A debt management plan is a proven method to pay off high-interest debts, like credit card bills, without needing a consolidation loan or filing for bankruptcy. Typically provided by credit counseling agencies, a DMP can help lower your interest rates, reduce monthly payments, and speed up the process of paying off your debts.
What Is a Debt Management Plan?
A debt management plan is a structured repayment plan set up and managed by a credit counseling agency. It focuses on helping you pay off unsecured debts, such as credit card balances, personal loans, and medical bills.
It’s important to note the difference between secured and unsecured debt. Secured debt, like a mortgage or auto loan, is backed by collateral (like your home or car). If you default, the lender can take the collateral to recover their losses. Because of this security, these loans usually have lower interest rates. Unsecured debt, on the other hand, has no collateral, which means higher risk for the lender and typically higher interest rates for you.
When you start a DMP, you’ll have an initial consultation, often free of charge, where a credit counselor reviews your financial situation. They may find ways to help you manage your money better, which could simply involve adjusting your budget to free up funds to pay off your debts. Credit counselors also offer financial education to help you improve your financial habits.
How Debt Management Plans Work
If you enroll in a DMP, the credit counselor will reach out to your creditors to inform them about your new payment plan. With your permission, the counselor will take over making payments on your accounts and may negotiate lower interest rates or more affordable monthly payments.
The counselor will let you know how much you need to pay each month to clear your debt. They’ll ensure the plan fits your income and expenses. You’ll send the agreed amount to the counselor each month, and they’ll distribute it to your creditors. You’ll also receive a monthly report showing your progress.
While in the DMP, you’ll agree not to use your credit accounts and avoid opening new ones. Some plans might require you to close certain accounts altogether. The goal is to pay off your debts, so it’s crucial to avoid actions that could hinder your progress. In return, your creditors expect you to make timely payments and stick to the plan until all debts are paid off. Missing payments could result in the cancellation of the plan.
Debt Management vs. Bankruptcy
The main difference between a DMP and filing for bankruptcy is that with a DMP, you repay the principal loan amount and a reduced interest amount. Creditors typically consider these debts as paid in good standing, which can improve your credit score.
In contrast, when you file for bankruptcy, creditors often receive little or no payment, and this is reported to credit bureaus, leading to a significant drop in your credit score. A bankruptcy filing stays on your credit report for up to 10 years, making it difficult to qualify for loans, and if you do, the interest rates will be much higher. Bankruptcy can also impact your job prospects, especially if the role requires security clearances.
Debt Management and Your Credit Score
There is one aspect of DMPs that could negatively impact your credit score: closing credit accounts. Closing accounts can increase your credit utilization ratio, which is the percentage of your available credit that you’re using. A higher utilization ratio can lower your credit score.
Lenders prefer that you use no more than 30% of your available credit. Closing an account reduces your available credit, which might push your utilization ratio above this threshold. On the positive side, keeping your debts current can boost your credit score. If a counselor successfully negotiates with a creditor to re-age your past-due accounts, they’ll be listed as “current,” which could improve your credit score.
Pros and Cons of Debt Management Plans
Pros:
- Professional Guidance: Receive expert advice and potentially lower fees and interest rates, helping you pay off debts faster.
- Simplified Payments: Instead of juggling multiple payments, you’ll make just one monthly payment, which could help improve your credit score.
- Stop Collections Calls: A DMP can put an end to collection calls, offering you peace of mind.
Cons:
- Fees: Credit counseling agencies charge for their services. Setup fees can be up to $50, with monthly fees as high as $75. Be sure to ask about fees before enrolling.
- Limited Use of Credit: Most plans require you to stop using credit cards and may ask you to close certain accounts.
Is Debt Management Right for You?
If you’re overwhelmed by credit card debt, personal loans, or medical bills, a DMP might be a good solution. It can stop collection calls and help you get back on track financially.
However, before you start a DMP, consider what caused your financial troubles. If it was due to circumstances beyond your control, like job loss or medical bills, a DMP could be a good fit. But if overspending is the issue, you’ll need to adjust your spending habits to avoid falling into debt again.
If a DMP doesn’t seem like the right fit, consider exploring other options, such as debt settlement, with the help of organizations like Debts free home. Once you’re debt-free, a debt coach can provide tips on how to manage your finances wisely and achieve your financial goals.